It is common knowledge that students who have amassed large college debt burdens cannot discharge those debts through bankruptcy.
That “knowledge,” however, is not really the case — the laws are written to permit discharge of student loan debts in some cases. And, with the federal government pushing for broader interpretations of those laws, they are now an incentive for students to amass debt and then dump it on the taxpayers.
The “undue hardship” provision in the U.S. Bankruptcy Code says that student loans cannot be discharged unless “excepting such debt...would impose an undue hardship on the debtor and the debtor’s dependents.”
Just how difficult is it for a student debtor to get a court to rule that having to pay off student loans would be an “undue hardship”?
Evidently, it’s not as difficult as most people think.
Writing on Huffington Post, Steve Rhode (who calls himself the “get out of debt guy”) states,
The general perception is that federal student loans are not dischargeable in bankruptcy. Obviously that assumption is not true because an allowance exists for discharge in the case of undue hardship. But many incorrectly assume that threshold is impossible or nearly impossible to accomplish.
Rhode finds the support for his conclusion in his analysis of 35 adversary proceedings in 2012 where the debtor sought discharge of student loans through bankruptcy. In those cases, the debtor won full discharge in 47 percent and received some reduction or more favorably repayment terms in another 33 percent.
Those 2012 numbers are in the same vicinity as the numbers calculated by Professor Jason Iuliano from cases filed in 2007, which formed the basis for his 2011 paper published in American Bankruptcy Journal, An Empirical Assessment of Student Loan Discharges and the Undue Hardship Standard. Iuliano found that 25 percent of the cases resulted in full discharge and 26 percent resulted in partial reduction or easier payments.
Having seen that the undue hardship standard isn’t as formidable as it’s cracked up to be, Iuliano wondered why relatively few people who have large student debts try using bankruptcy. One answer he advanced was that individuals probably think that they have little chance of winning unless they hire an experienced (and, naturally, expensive) lawyer.
Unexpectedly, however, Iuliano found that many of the successful debtors did not have legal counsel. They represented themselves.
One example is the recent Alabama case, Acosta Conniff v. Educational Credit Management Corporation. It is pertinent for two reasons: the success against the undue hardship standard and the fact that the debtor acted as her own attorney.
The bankruptcy court discharged the debtor, Elizabeth Acosta-Conniff of her $112,000 in student loan debts. She had gone to school wanting to become a special education teacher and to obtain the degree she wanted (a Ph.D., which she took at Auburn), she racked up a lot of debt.
Her pay as a special education teacher in rural Alabama left her needing financial assistance from her parents to get by. Applying the “Brunner test” used by most bankruptcy courts, Judge William Sawyer ruled that she was entitled to discharge because the payments kept her from having a minimal standard of living for herself and two children, because she had made good faith efforts at repaying, and because her circumstances were not likely to improve.
As word gets around that a teacher in Alabama has single-handedly beaten a large, legally sophisticated company that holds a great many student loans, no doubt we will see more cases like this.
Further, the Department of Education recently released a “guidance letter” pertaining to undue hardship discharge cases. The letter tilts the scales more in favor of students who are petitioning for bankruptcy discharge.
It instructs “holders” of student loans (i.e., the organizations that actually collect on them, such as ECMC) to first “evaluate a borrower’s undue hardship claim and determine whether the holder believes that repayment would constitute an undue hardship according to standards set by the Federal courts.”
(These “holders” are private firms that have contracted with the Department of Education to oversee student loans. They earn fees by collecting from students who have defaulted, but if the loans are uncollectable, the loss falls on the taxpayers. For more information on the loan collecting system, this Bloomberg piece is informative.)
The letter goes on to acknowledge the obvious — that discharge imposes a cost on the taxpayers — but advises the holders against automatically contesting discharge. They should evaluate each case and give in if they think the borrower will face undue hardship.
Additionally, holders are told that even if a case does not seem to present undue hardship (in other words, a case they could win), they should then “evaluate the cost of objecting to the borrower’s claim of undue hardship in court.” So, if the cost of the litigation is expected to be $50,000 and the amount the borrower seeks to discharge is $49,000, the holder should consent.
What is missing from the guidance letter is anything regarding a penalty or sanction if a loan holder fails to properly do the two analyses and contests cases it should not.
Pressure from the Department of Education to relax efforts at making student debtors pay their obligations is consistent with the general approach the Obama administration has been taking. The president’s programs make payments depend on earnings and forgive balances after 20 years — and only 10 years for those who find jobs in “public service.”
Those policies will appeal to students, but they encourage them to keep amassing debts in pursuit of costly credentials that are unlikely to lead to jobs that will pay well enough to cover their debts.
Even if we can’t reverse that general policy mistake, the extreme messiness of the dischargeability of student loan debts should trouble us.
Students are encouraged to borrow heavily for degrees that are unlikely to pay off financially — such as Elizabeth Acosta-Conniff. Then, some of them will succeed in escaping from their debts in bankruptcy, but only those who a) are aware that the “you can’t discharge student loan debts” notion is mistaken and b) get their cases before sympathetic judges.
It’s quite “hit or miss” and that is never good in public policy.
Congress can and should clean up the mess.
The first step would be to restore the bankruptcy code to its pre-1977 terms, under which there was no distinction between student loan debts and any other kinds of debt. If someone qualifies for bankruptcy, the reason why shouldn’t matter.
That change would make private higher education lenders far more circumspect about their loans. Many students might be turned down, but for the good reason that their educational “investment” looks like a bad one.
At the same time, Congress ought to change federal loan policy to require the schools that have received Title IV loan money bear some responsibility if the student defaults on the payments, whether or not he is declared bankrupt. That “skin in the game” rule would compel colleges and universities to evaluate the risk of enrolling any student.
Educational institutions would then have an incentive to compare costs with anticipated benefits, performing the analysis that too many students fail to do. By restoring the proper incentives for all the participants in the student loan process, we would probably see defaults, which have been rising in recent years, start falling without causing undue hardships on anyone.